Contents

Introduction

The Canada Business Corporations Act(1) (CBCA) imposes statutory liabilities on directors of federally incorporated companies. In addition, directors can be held liable for a breach of their fiduciary duties owed to the corporation. This paper provides a brief review of relevant CBCA provisions and discusses some of the policy issues surrounding directors’ liability, in particular efforts to expand the class of stakeholders to whom directors owe a duty.

Fiduciary Duty and Standard of Care

The common law, the Quebec Civil Code and corporate statutes impose duties on corporate directors. One of these is a fiduciary duty not to place themselves in a position where their duty to act in the best interests of the corporation conflicts with their personal interests. This principle is codified in section 122(1)(a) of the CBCA, which states that directors of a corporation must “act honestly and in good faith with a view to the best interests of the corporation” when exercising their powers and discharging their duties.

Another of a director’s duties is to maintain a standard of care when managing the corporation. The statutory standard for the amount of care, diligence and skill required of corporate directors is derived from the common law and has been codified in section 122(1)(b) of the CBCA, which requires directors to “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” Directors are thus required to use their training, ability, experience and education in the same way as a reasonably prudent person would do in a similar situation.

Directors' Statutory Liabilities and Defence Mechanisms

The CBCA (and provincial corporate statutes) imposes specific statutory liabilities on directors of corporations. Under a number of CBCA provisions, directors can be held liable, for example, for the authorization of share issues at less than fair market value, or for unpaid wages and vacation pay owed to employees. Under numerous other provisions in federal and provincial statutes, directors may also face personal liability for, among other things, environmental offences, source deductions from payrolls, and tax remittances.(2)

Corporate directors have a number of defences to legal actions in which it is alleged that they have breached their statutory or fiduciary duties:

A corporate director may dissent from a resolution passed or action taken at a board meeting. Under many statutes, this will relieve the director of any liability for the results of that decision.

The CBCA also allows directors to raise a “good faith reliance” defence to an accusation of breach of a fiduciary duty found in section 122(1) of the Act. Under this defence, the director is entitled to rely in good faith on financial statements or reports made by an officer of the corporation, the corporation’s auditor, or by other professionals, such as a lawyer, an accountant, or an engineer.

Directors may also avail themselves of a due diligence defence. Section 123(4) of the CBCA permits directors to avoid a number of statutory liabilities, including breach of fiduciary duty, where the directors exercise the same degree of care, diligence and skill as a reasonably prudent person in comparable circumstances. In exercising due diligence, directors are entitled to “good faith reliance” on financial statements and reports, as previously outlined.

Expanding Directors' Statutory Liability

The scope of directors’ liability, especially for breach of fiduciary duties, has consequences both for corporate governance and accountability, and for business efficiency. Changing the law to make directors personally liable is a relatively simple way to influence corporate behaviour. However, enlarging the class of stakeholders to whom a duty is owed may alter the traditional motivation of corporations, that of maximizing shareholder value. An expansion in liability may impose greater compliance costs on the corporation for such items as fees for professional advice, and for errors and omissions insurance purchased by the corporation to protect directors. If directors are subject to excessive personal liability, they may resign, or refuse to serve on boards.

Although the corporation may choose to insure directors against liability, the directors remain personally liable under the legislation. Corporate accountability relies on this principle; without the threat of personal liability, a moral hazard exists. Directors may have less incentive to provide independent oversight of the corporation, and may be less likely, for example, to take actions to prevent a misallocation of resources, which would be to the detriment of the corporation’s shareholders and employees. Directors’ liability underlies effective risk-allocation, and helps to set clear lines of accountability, which is particularly important in the event of corporate malfeasance.

Any expansion of statutory liabilities must balance competing interests. The addition of personal liabilities may make corporate management more responsive to regulations designed to protect the environment, for example. However additional liabilities may also make Canadian companies less competitive by increasing their compliance costs, and if directors face increasingly onerous personal risks, qualified directors may choose not to serve on corporate boards, and the quality of corporate management may decline.

The Stakeholder Debate

Current debates over the scope of fiduciary duties owed to stakeholders illustrate the clash between the competing objectives of corporate accountability, which compels the corporation to be more responsive to public policy concerns, and business efficiency, which makes the corporation a more profitable and effective enterprise.

Under the shareholder primacy model, a director’s duty under section 122 of the CBCA to “act honestly and in good faith with a view to the best interests of the corporation” has been interpreted to mean acting in the best interests of the shareholders.(3) Decisions taken by the board are expected to maximize share value. For example, under the shareholder primacy model, corporate directors would approve a charitable donation from the corporation in order to improve the fortunes of the corporation: it is expected that by giving to the charity, the corporation would boost its public image and therefore its business prospects.

Proponents of corporate social responsibility argue that acting in the best interests of the corporation does not preclude directors from acting in the interests of outside stakeholders, such as employees, creditors, suppliers, customers and the community in which the company’s operations are located. A number of commentators believe that shareholders should be considered only as part of a broader class of stakeholders, and that stakeholder interests as a whole should be used when determining the best interests of the corporation. The shareholder primacy model, it is argued, acts as a restraint on directors, because the only goal is short-term profit maximization.(4)

The leading Supreme Court of Canada ruling on the fiduciary duty of directors, Peoples Department Stores Inc. (Trustee of) v. Wise(5) has done little to clarify whether corporate directors owe duties to outside stakeholders. In Peoples v. Wise, the Supreme Court held that while directors owed no fiduciary duty under section 122(1)(a), they did owe a duty of care under section 122(1)(b). The Court firmly rejected the shareholder primacy model, but it does not seem to have fully endorsed the stakeholder theory. Commentators have suggested Peoples v. Wise “failed in terms of defining precisely the content of and in recognizing the distinctions between the duty of loyalty, duty of care, and oppression,”(6) and introduced a level of uncertainty in the law that provides little guidance to directors in exercising their duties.(7)

The Supreme Court rendered its decision in Peoples v. Wise in 2004. Since that time, there does not appear to have been any movement by the Government of Canada to clarify the law. However, serious policy issues on the role of corporate directors remain, and in the absence of a set of clear judicial standards, amendments to the CBCA by Parliament may be required.

Conclusion

Directors’ liability is one of the primary instruments used by policymakers to promote good corporate governance. However, the past decades have seen a rapid expansion in statutory liabilities, and a broadening of fiduciary duties imposed on corporate directors by Canadian courts. The imposition of ever-increasing personal liability on directors may eventually affect the management and business efficiency of Canadian corporations. If that is the case, amendments to the CBCA that place limits on the personal liability of directors may become necessary.

Endnotes

* This paper draws from a paper with a similar title prepared in February 2000 by former Library of Parliament analyst Margaret Smith.